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Some ideas for the car industry

The Age published a piece of mine on the car industry today. It appears in the link just provided, and also – in case the link is broken in future and because it’s slightly edited in The Age – in its original form beneath the fold.

Some ideas for the car industry

In economics as in life, problems seem to come in waves. Right now for the car industry things aren’t so good. Real wages keep rising, powerful new competitors loom to our north and we’re releasing a new crop of bold new big cars all planned when petrol cost about half what it does now.

It’s all eerily similar to the mid 1970s. Then, minerals and wages booms massively undermined the industry’s economics – just after it had released its largest, most gas guzzling cars ever. The P76 was the most famous like the Titanic taking its maiden voyage straight to sea floor and into cautionary legend.

Then the powerful new competitor was Japan. Now it’s China and India.

Then our response could hardly have been worse. We closed four fifths of our local car market off to imports. And, on the motion of a young back-bencher from Bankstown, Paul Keating, so called ‘non-reversion rules’ required manufacturers to get government permission to switch from local to imported components which was typically withheld if the local component supplier wasn’t happy.

Economic reformers were right in trying to end this madness. But they mistakenly took the whole industry to be a basket case when large car manufacture was (as it still is) pretty competitive. And during the lengthy phasedown of protection they favoured tariffs, instruments well suited to containing the cost of protection, but which nevertheless prevented competitive manufacturers using their protection to help defend and build export markets.

For a disastrous decade we turned our energies to stopping Corollas get into the country so we could make them here. Costs rose, exports collapsed and we made Corolla’s and their competitors Holden Geminis and Ford Lasers at near infinite rates of protection!

We won’t do anything so stupid this time. Still as Mark Twain observed, history might not repeat, but it does rhyme. Then, as now, there’s a high and a low road. Then as now, focusing on mere survival we avert our gaze from the high road.

Virtually the whole industry is in survival mode hanging on to what it can. We’ve been to America and Japan begging the car manufacturers to buy more local components.

Meanwhile the industry honoured its bargain with the Government to let tariffs fall from 15 per cent to 10, pending its fall to 5 per cent at decade’s end. None of this makes any sense but not for the reasons you’re thinking. Of course it will harm the industry, but that would normally help the economy move resources into more efficient industries.

But below some level, cutting tariffs actually makes little sense like some economic advice followed during the depression, the pain appeals to our sense of virtue but it’s just pain. Why? Because cutting tariffs increases imports which must be paid for by increased exports. And for some exports like wool and wheat and coal we can’t increase them without cutting their price.

So, as the Productivity Commission’s modelling illustrates, the economic gains from shrinking the industry a little are outweighed by losses from export price falls. The argument is actually stronger than this, but the industry hasn’t funded the necessary work to demonstrate it.

But all of this pales into insignificance next to the question of how Australia’s and Asia’s car industries are integrated. Back in the 1970s our approach to Japan should have been similar to the Canadians’ approach to America. Just when we were closing off our markets with local content plans the Canadians had a simple message for the Americans. You can export your little heads off into our market, so long as we’re assured a place in the production chain.

It was the most successful piece of automotive industry policy in history from which the Canadian industry has grown to around four times the size of ours and ten times the profitability.

In fact in automotive manufacturing we are an almost perfect fit with China and India we can completely design and build well styled, well made vehicles. They can’t not yet anyway. They have no shortage of investment capital, low labour costs and burgeoning domestic markets. They’ll make good cheap cars, we’ll make good large rear wheel drive ones. So the potential is there.

But as we explore a free trade agreement with China these thoughts are far from our minds. Yes, vehicle exports to China rate a mention, but as ever both political structures and our picture of ourselves as a primary producer means that we see our main task as negotiating access to Asian markets for primary produce.

Of course better access for our farmers should be a high priority. But we must also build our trade diplomacy around a proposition countries with different economic structures to our own grasped long ago that trade within industries is becoming progressively more important than trade between them with each passing year.

When you’re hanging on, white knuckled, trying to survive it’s not easy to think of the bigger picture how to build towards a prosperous place in the regional division of automotive labour. Then again, industry executives fighting their way through the hand to mouth existence they’re now leading know that we’ve been here on and off since the 1970s.

And they might reflect that while most auto industries in developed countries are going through hard times, Australia’s has never cracked $1 billion in profits. It made just over $100 million in 2004. Meanwhile in Canada their profits are down to around $5 billion after a string of years making $10 billion in the late nineties. But they’re expected to recover.

They took the high road. We can too. All it takes is a little imagination.

36 thoughts on “Some ideas for the car industry”

I lost the quote unfortunately, but one of the Holden Managers/engineers said something along the lines that Holden is an exporter of knowledge. The development of the zeta platform is an example of that. I also recall a reporter getting upset that Saab was thinking of building Commodores for the EU/US market, a Holden manager said setting up a factory is the cheap part, the expensive part is developing the platform.

Australia doing the development and engineering for a platform that will under-pin prestige products like the Holden Monaro, Pontiac GTO, Chevrolet Camaro and possibility Cadillacs too is a big deal.

I disagree with the basic strategy you’re pushing here, as well as with many of the detailed assertions: “We can completely design and build well styled, well made vehicles” – they’re not well designed if they don’t meet the market, and the build quality still has a way to go to meet even Korean standards. We’ve got American-style engineering (ie conservative) without the American volumes that justify it.

We can’t hope to match the Asians at the cheap end of the market and can’t hope to match the Europeans at the prestige end. And anyway it’s ridiculous to try and support four manufacturers – we just might manage to carve out a niche if we had one or two, but not four.

We are a very sparsely populated country with huge distances to cover; keeping the cost of cars down is more important than in more compact countries. The day the first FB Holden rolled off the assembly line was a black day.

‘Because cutting tariffs increases imports which must be paid for by increased exports’.

This applies to any tariff reduction proposal. It seems to be equivalent to one of the oldest and most obviously fallacious arguments against protection. You can say that the deadweight losses saved by cutting protection from 10% to 5% won’t be much more than a little tiangle – the gains are proportional to the tariff reduction squared so they won’t be huge – but that’s about it.

With the ACIS scheme currently in place – which accounts for about a quarter of all Australian industry protection – the Australian automobile industry remains heavily – and ineffectively – protected .

Australia’s speciality has always been large-medium vehicles and car design and until recently we have done well at this – but I wonder if even these market niches will survive the China challenge.

How on earth will forcing lower car prices through reduced protection force mineral exporters to cut their prices? They have market power according to your view – hence your appeal to the ‘optimal tariff’ argument. According to your reasoning, if tariffs are cut on a cars you would need to cut export prices on mineral exports.

And yes according to your reasoning this applies to any tariff reduction at low levels. The argument sounds dead wrong to me but, even if it were true, why not for small cuts at higher levels.

The outrage is based on your proposing an argument that no student of international economics would buy. Certainly no student of ‘optimal tariff’ theory.

Do you have the PC reference where they reject the case for reducing tariffs to zero on the basis of optimal tariff arguments?

What Harry said – about the only major export for which the ToT argument is at all plausible is wool, and we’ve long since ceased riding on the sheep’s back. As for hte modelling, you know as well as I do the sensitivity to elasticity parameters of these sorts of results in a CGE.

On build quality, ask your friendly local mechanic. And Holden, Ford and Mitsubishi still only offer short warranties – they don’t put their money where their mouth is.

I’m no fan of Volvos, but they’d be priced rather less if they didn’t carry a tariff. Then of course there’s those non-tariff barriers – the effective abolition of the low-volume import scheme, the ban on Japanese used cars, the peculiar ADRs.

Frankly I’m sick of hearing the local industry saying “we used to make expensive rubbish but it’s real good stuff now”. It’s a story I’ve been hearing since I was a kid.

And I think you’ve evaded the point about four manufacturers. Mate, tell us straight – do you think it’s too many or not?

It’s not only bad manners, it seems to me to be bad science to assume you’re arguing with a complete nincompoop. Of course it’s always possible, but I think you should come to the conclusion more slowly.

You should read what I say more carefully. I did not say that the PC argues against reducing tariffs to zero on the basis of the terms of trade argument. I said that their modelling shows the costs of tariff cuts in generating terms of trade losses

Who said we ‘need’ a car industry? Not me. We should keep it if it can compete, and not if it can’t.

On the other hand if it can compete at a moderate tariff level and a good case can be mounted that reducing tariffs below that level would actually cost the economy more than it would help it, then call me old fashioned, but I reckon you’d be a bit of a mug to reduce the tariff below that level.

This is a bit frustrating. You have every right to say whatever you like however accurate or not (more of that in a sec) about the Australian industry, but given you’re placing it on this thread it gives the impression of bearing on my arguments.

The last line of your last comment in particular seems to suggest that I’m some champion of the local car industry. I’m trying to put forward some economic arguments. Not champion the car industry. I think you’re projecting some identity onto me as some standard proponent of protectionism that needs to be projected elsewhere.

You want me to tell you how many plants there should be? Why does this task fall to me? Is it to flush me out as some reflex defender of the car industry

Nic – don’t get frustrated. I don’t think Harry thinks you’re a nincompoop, and I most certainly don’t.

Look, there’s no doubt you know a lot more about the Australian car industry than me. You’ve had professional involvement, I haven’t (I don’t know about Harry).

But I do know that this industry has a miserable history of special pleading, and they brought out consistently awful products for many years. Really, you can’t blame us for having strong priors against arguments for it’s protection.

Yes, their build quality is better now – but I’m still not convinced that it’s as good as claimed. And the engineering (live rear axles and pushrod V8s, ferchrissakes!) and styling is conservative – but I’ll concede that de gustibus … etc.

Back to the issues, let’s get real – the net welfare effects in either direction of a 10% tariff are probably very small. So I’d be inclined to get rid of it on political economy grounds to reduce future special pleading and pour encourager les autres.

And it’s the political economy I worry about, fostered by the unsustainable nature of the industry’s structure (hence my pressing you on the number of manufacturers). The non-tariff barriers – done via the back door of lobbying Ministers – illustrates my point (BTW, that’s a remarkable claim of the PC that import of Japanese used cars would cause ‘undue disruption’. Well yes, competition tends to do that). As does the last extension of the tariff and the subsidisation of Mitsubishi by the SA government.

Of course, in the longer run I reckon Chinese cars, and then maybe Indian ones, are gonna sweep the bottom end and push the other importers upmarket anyway. So competition for the locals is only going to get fiercer (their postioning for this is not helped, of course, by designing new cars on the assumption that $20 a barrel oil will continue indefinitely).

Nicholas, I didn’t say or suggest you were a ‘nincompoop’. The point was directed at your argument that optimal tariff arguments can justify a case for low levels of protection. In fact the PC figures you cite do not support this claim – on the basis of the figures you present there is a small GNP gain from abolishing protection with or without any assumed ‘cold shower’ effects.

While you claim you said originally that the PC showed ‘terms-from-trade’ losses from tariff cuts that isn’t what you originally said at all. And again in the third last para of your reply you claim ‘reducing car tariffs …produces a small welfare loss’.

We might have once had very limited monopoly power in wool markets and perhaps now in minerals markets and on certain aviation routes. But I doubt these are large enough to foster even a limited case for protection though I agree the gains from abolishing protection at low levels of protection are low.

There is no first best case for slapping ‘first best’ export taxes on coal and mineral exporters if these firms are already extracting monopoly rents.

I am suprised that you react with such fury to both DD and myself. Maybe a ‘cold shower’.

Harry you said that I was proposing an argument that was outrageous, and that “The outrage is based on your proposing an argument that no student of international economics would buy. Certainly no student of ‘optimal tariff’ theory.” That seems to me to be a casual claim that my case is the product of simple ignorance.

In response I’ve gone to some lengths to try to engage you on the points you made, but it doesn’t seem to me that you’ve responded in kind by really addressing the points I’ve tried to make.

You say this “While you claim you said originally that the PC showed ‘terms-from-trade’ losses from tariff cuts that isn’t what you originally said at all.” Please clarify because I don’t follow. What did I say originally that is inconsistent with this?

Why do you take long run GNP to be a better measure of welfare than long run consumption?

I have clearly stated why I object to your claim that optimal tariff theory can be a useful justification for retaining low levels of protection.

On the other hand I do not object to the argument that the gains-from-trade will be small. They will be be for well-known reasons.

You didn’t talk about terms from trade losses from tariff cuts in your first post. That came after I asked for the PC evidence which, regrettably, does not support your arguments – tariff cuts provide a gain in GDP according to the PC. You want to use consumption but even here, in the PC’s preferred estimates, your claim does not obtain – consumption rises a bit with tariff cuts.

I would use GDP as a welfare measure because that is standard in this setting. Private consumers are not the only agents affected by trade policy as the PC data makes clear. By the way I wouldn’t defend these simulations either – I wonder whether the Monash people use estimated trade price elasticities or whether they are ‘calibrations’.

You made strong claims about tariff policy based on some simulations done for the PC in 2000. It is reasonable to seriously question these claims on theory grounds (where is the monopoly power) and empirical grounds (are these results borne out by evidence?).

Perhaps you’re right to say I’m too serious about it. Perhaps I am. But on blogs it’s easy to misunderstand someone’s tone. I’m in no particular ‘fury’ to use your word.

I’ve defended my arguments both vigorously and I think meticulously. This was in response to being told that my argument consisted of simple fallacy that anyone really practicing in the field would recognise. Isn’t it OK if I respond with vigour to that assertion?

I’ve tried to respond to each of your arguments and have done so trying to put your arguments in their best light. I have done so in reasonable detail and tried not to misunderstand or misrepresent you.

My purpose is to try to improve our arguments and narrow differences.

I can’t follow your arguments which seem based on impressions you have formed, rather than words I have used. In your latest comment you say “You didn’t talk about terms from trade losses from tariff cuts in your first post. That came after I asked for the PC evidence.” To start with, I’m not sure what that point is in aid of – what point you’re making really. It was an op ed in which I was juggling a range of objectives as you can appreciate – brevity, engaging the interested, non-expert reader etc.

But because I am pretty conscientious about these things and try to smuggle as much good quality argument into an op ed as I can, I thought I mentioned terms of trade losses loud and clear.

The initial post is up there. This is what I say. “. . . cutting tariffs increases imports which must be paid for by increased exports. And for some exports

I don’t have anything to add to my previous post. I use GDP rather than consumption because it is a broad measure of income change and the measure conventionally used to approximate the sum of consumer and producer surplus gains from a trade liberalisation. The PC found that GDP fell when tariffs were cut not that it rose. Even using consumption the PC in its preferred model rejected the idea of a fall as a consequence of the cuts. I didn’t raise the issue of the PC evidence – you did. I rarely believe simulations derived from the Monash model because I suspect the elasticity ‘data’ used.

Originally I reacted to your argument by reading it as the old mercantilist view that the way to wealth and advantage is to expand exports and restrict imports. Taiffs as a way of deasling with trade deficits.

I see JQ has posted on this on his blog. I’ll be interested to see the exchange there and will hop back in if something new arises. Otherwise I stick to my view that the monopoly power we exert in exporting wool, minerals and air services is unlikely to be significant enough to motivate a case for low uniform levels of import protection.

Like you I accept the proposition that the gains from cutting protection from low levels to almost zero levels is low. Abolishing the ACIS scheme for Australian car assembly – this is output-related and a pure handout to foreign multinationals – is likely to produce much bigger welfare gains for Australia than cutting low tariffs.

Consumers in general would not be better off. Consumers of cars without any other stake in the economy would be better off I guess as they would be paying less for their cars. Remember my argument is that in this situation, welfare is reduced despite this effect and its result – a shrunken car industry – which other things being equal is a good thing.

Against the pure gains for car consumers are the losses to the exporters of certain commodities who suffer small price reductions. And ultimately there are lots of consumers amongst those exporters and beyond some point the losses on the export side outweigh the gains on the car consumption side. Hope that makes sense.

I think countervailing duties are a red herring here. In general they’re imposed by one country against another’s exports on the grounds that the exporter’s exports are ‘dumped’. Generally from the perspective of the importing country dumping is a good idea – who wouldn’t want others to subsidise them? But I’m not sure I’m addressing your point because it’s not made at much length and it’s not entirely clear.

OK, Australia faces downward sloping demand curves for only a few primary products:

wool (relatively inelastic – but a product for which consumers have been substituting away from given the advances in apparel from ‘synthetic’ fibres – the deamnd curve appears to have been moving inwards for the last 5 years) beef (only slightly elastic – and which will completely flatten out when South American countries complete the disease management programs)and iron ore (a nice little international oligopoly) but I’d doubt that’s the case for thermal coal – maybe met coal?.

We have no market power (as it relates to an individual producer influencing prices) in those markets, except iron ore, because the production side in Australia is made up of many producers – so, an argument for an optimal tariff can be made for wool and beef – regardless of where you sit with tariff reductions. (Note Rio and BHP already do that for us (them!) for iron ore).

Turning to the model outcomes, the product differentiation assumptions used in CGE models (which mean relatively inealstic substituion options – compared to ‘reality’) means you need large price movements for small changes in quantities. So when we get to modelling small changes you may end up in a world where you get welfare losses at small changes when you’re near the optimum. Changes that would outweigh the benefits from optimal tariff setting – and so maintaing a small tariff makes sense.

But for those applied modelling reasons, I’m a little more sceptical about the simulated results – and hence the arguments that small tariff on cars can be welfare enhancing (as a second best policy). Even more so when I think about the specifics of those goods (and their current market characteristcs) for which we face downward sloping demand curves.

But perhaps I’ve overlooked other goods for which we (Australia) do face downward sloping demand curves – and which are large in terms of their GDP impact?

Thx for the comments Christopher and I’ll ask our webmeister to look at the the HTML lists issue you raise. (Actually looking at the text you posted, I’m not sure what you’re saying – as there’s no code for a list in the email feed I’ve got from your comment. Can you clarify?)

On the substantive points, what I’ve argued is predicated on the effects being small. It’s just a case of whether we can expect a positive or negative result in the end.

On your point about the monopoly power of producers and competitiion within Australia, I think it’s round the other way – or perhaps I’ve misread what you’re saying. If our producers compete with each other in export markets, then the only way to stop them competing away the margin is with some change in their environment which raises all of their prices – as maintaining tariffs would (via the exchange rate).

Where a firm has monopoly power itself, you don’t have to worry as much as it will be the best judge of how to use it. (There are issues of who gets the rent and also of the fact that an while an oligopoly will keep some monopoly rent, it will give a lot of it – probably most – away).

The market power comments were a brief response to Harry Clark and not about competition in the domestic market (or how to stop them competing away the margin – which I don’t think you can anyway).

I thought I was filling in the dots you had left behind (about the optimal tariff) – that even though the aggregate of Australian production for wool and beef faces a downward sloping demand curve – that the individual farmers act as price takers means an optimal tariff can be welfare enhancing for Australia through extracting rents from the rest of the world. Of course, in the absnece of non-production related compensation, the farmers won’t see their welfare enhanced because they can only receive the (lower) pre-tax price and thus restrict production.

(Perhaps that little side trip didn’t need to happen – but you were motivating the welfare effects as analogous to thinking about optimal tariffs.)

So when thinking about the alternative policy of a small tariff on imports (noting that this is not quite an optimal tariff story coz it affects all exporters), it’s important to think about the market characteristics of those products for which we (Australia, rather than individual producers) do face downward sloping demand curves.

What I was saying (ineffectually) was that, historically, we did face that situation for a limited number of commodities – but looking forward, I see that changing (reasonably quickly). So discussions about the welfare enhancing effects of small tariffs motivated by downward sloping demand curves for (some) exports have less support than they did – even 5 years ago.

And I agree, that a world market for which 1 (or 2!) Australian firms were the dominant suppliers, those firms would be the best judge of the ‘optimal’ tariff – I thought that’s what I had said.

Finally, the html comments related to using the UL and LI tags for lists. I did that for the paragraph where I set out the characteristics of the demand for beef, wool and thermal coal. In the preview sreen below the textbox widget where you type, they had nice identing, dots etc…all the things you expect. But when I hit submit, the final copy didn’t have any of it – making that para harder to read. I suspect the email you receive is the one after the post goes through the filter that strips out all those ‘bad’ html thingies site operators don’t want (but list tags are fairly innocuous).

The argument that Nicholas has propounded and which John Quiggin seems to have supported is just wrong.

I think they have in mind a simple two good model where the Lerner symmetry condition implies that it doesn’t matter whether you levy an export tax on goods in not perfectly elastic supply or levy tariffs on imports. In this simple two good model that it doesn’t matter which traded good you tax to exploit the optimal tariff argument. Levying a tariff on imports in a two good world will generally drag resources away from the export sector, reducing output there and potentially advantaging the economy from an optimal tariff viewpoint.

But in a model that even broadly captures the features of the Australian economy this argument breaks down completely. For example if you have market power only in wool exports and you put an import tariff on car imports, then in general, that tariff will draw resources away from all sectors, not just the wool sector. Lerner symmetry breaks down entirely.

And given the vastly different production technologies in play here a tariff on car imports may not draw any resources from the wool sector – instead it will draw resources away from industriies with no export market power at all. In this case the economy will be worse off with any non-zero tariff on car imports.

In general you can’t draw any conclusion without paying attention to the nature of complementarities and substitutabilities in the use of inputs in the economy as a whole. To suggest there is some general argument for low tariffs is an erroneous conclusion.

And to present the rejection of this fallacious argument as JQ does as a kneejerk rejection of any argument against free trade is unfair. This is a very specialised argument that will almost never be correct. The difficulty with these fallacious arguments is that they create the impression – on the basis of an inapplicable 2*2 trade model – that there is a general argument for low levels of tariff protection in any economy with some market power in exporting. Since this would apply to almost any economy it would suggest a general case against free trade.

There is no such general case and , in particular given the lack of input substitutability between the car industry and those industries where Australia dioes have market power there is no specific argument for low levels of import tariff protection in this particular setting.

Harry, even on the informal logic of your argument the position is ambiguous and depends on what resources are drawn from where and where they go. To the extent that the economy adjusts to reduced tariffs through a lower exchange rate, then the result will be an expansion of export sectors. Many export sectors can expand without depressing their export prices, but some can’t and their expansion depresses their prices.

It seems to me to follow that the optimal tariff is therefore positive. (Always allowing that the optimal trade policy response is a targeted export tax). The remaining issue relating to this argument then becomes whether this postive number is very small (in which case it’s best to forget about it) or just moderate to small – say 15, 10, 5%. Of course that’s not clear from informal reasoning.

But isn’t that why we have CGE models? To try to add up all the columns and give us the best answer to this question we can in our ignorance get? Well the Monash and the Murphy Models say that the positive tariff is not very small – it’s moderate.

Regarding the choice between production and consumption as an indicator of welfare, this is what the PC said in its 2002 report on autos (p. 302).

[A]ssuming that the long run real wealth of Australians was the same under each policy option as in the basecase . . . all of the impact of the policy options would flow through to aggregate real household consumption, which could then be used as a single unambiguous indicator of changes in economic welfare.

production is meaningless except as it relates to consumption. the USSR at times had extremely high production but relatively low consumption, but consumption is welfare, not production.

anyhoo, the assumption underlying those models is presumably that we will import more cars, necessarily affecting exports, but local car manufacture could become more efficient in the face of cheaper imports.

secondly, do falling export prices mean lower profits for exporters? perhaps they will be exporting more at lower prices which enables them to produce units more cheaply.

third, and i think most damning for any level of tarrif, is these models fail to account for second round effects of having cheaper better cars and goods in general. these enable other industries to make advances which is the true underpinning of growth. there is strong historical evidence that small changes in freedom of markets can exceed the immediate growth effects (through of course technological progression)

having said all that, i agree with gruen’s points re: political practicalities although dont think the farm lobby would necessarily pick up on the link (although i have no idea how savvy their economists are)

Aint many economies of scale in growing wheat and wool. There are some in handling and transport, but disecoomies of scale as you move to progressively more marginal land in the growing. An old point of Ricardos (though others may hve mentioned it before him).

The history of trade liberalisation seems to show that there are strong gains from liberalising high tariffs. It also seems to show that there are strong gains from (the right) bilateral or plurilateral free trade agreements. What experience demonstrates strong gains from reducing relatively low tariffs?

No appeal is made to ‘losers’ or to compensation. The argument is a pure efficiency argument (though an appeal to principles analogous to the optimal tariff argument on the export side means that the policy is less efficient than a targeted export tax).

So I’m not sure what ‘second round’ effects can be appealed to, and as you have no doubt said said yourself on more than one occasion C8to;

SOME ISSUES IN SEEKING TO DEVISE AN OPTIMAL TARIFF: THE PC’s 2008 AUTO REPORT

Sorry for being a bit late with this, but here is what the PC said on the issue in its recent auto report:

Being a relatively small part of the world economy, Australia is generally considered to be a price taker in world markets. However, our share of world trade in certain commodities, and in some instances the possibility of taking advantage of seasonal and/or regional variations in demand and supply, may in theory be sufficient to allow the exploitation of market power in those markets by manipulating trade flows.

Were this the case, there would in theory be a set of ‘optimal’ import tariffs and/or export taxes that exceed zero. These trade taxes would be optimal in the sense that they would facilitate the extraction of ‘rents’ from foreign suppliers and buyers by restricting flows of imports and exports. Although these taxes would leave Australia’s trading partners worse off and generate net costs globally, they could in theory generate net benefits for Australia, outweighing the efficiency costs of the tariff protection.

To exploit any market power Australia might have in commodities markets, the ‘first best’ policy approach would typically be to tax or otherwise directly control exports of the relevant commodities, such as iron ore, wheat and wool, taking into account developments in international markets.

It has been suggested that tariff protection for the automotive industry could also allow Australia to benefit in this way, as holding resources in the automotive industry would indirectly restrict the expansion of export industries, thereby limiting the terms of trade losses that would entail. In this context, if Australia were assumed to exert sufficient influence over prices received in foreign markets and an economic model was specified accordingly, it should be possible to derive the result that an increase in automotive tariffs (holding all other tariffs constant) would generate a net benefit for Australia.

However, it should also be possible to obtain the same result for an increase in tariffs on any randomly selected imported item. Individual tariffs devised on this basis, whether for cars or other products, are unlikely to be ‘optimal’. In practice, seeking to devise optimal tariffs to generate terms of trade gains would be a complex and fraught task. To seek to capitalise on any gains Australia might be able to derive from market power in certain commodity markets through a specific tariff on automotive imports would likely be far from optimal in an economy-wide sense.

That’s all given. But saying that doing something else is ‘first best’ is a somewhat unhelpful throwaway line.

The fact is that if the model the PC refers to in the second last paragraph tells you that cutting car tariffs generates welfare losses, it’s a bit of a dumb thing to cut them – don’t you think?

It’s true that if you believe the model it would lead you to a set of ‘optimal export taxes’. But most of us are not silly enough to work that way – that is to take a model and take it so seriously as to try to optimise policy to the nth degree from it. The argument is rather this – the most plausible you can construct tells us that the average export elasticity of demand facing Australia’s exporters is around -10 – though Monash modellers think it’s about half that. The PC argued that -10 was an OK export elasticity of demand. I think it’s probably a bit below that, but more than Monash’s preferred -4 or -5. The fact is that we’re all guessing. Be that as it may, if the elasticity is -10 as the PC assumed, unilaterally cutting tariffs below 11% starts doing more harm than good.

It’s true that the PC seems to have got modelling results that somehow defy these fundamentals. But I’m afraid they don’t pass the laugh test. Can you tell me any other rearrangement of half a billion dollars of government revenue – from one source (tariffs at a low rate) to another (some form of revenue raising that has no efficiency costs) which nevertheless generates gains of over half a billion. Do you believe that?

In the meantime, here’s how we concluded our report.

We conclude by emphasising the modesty of the position outlined here. It is true that if the considerations explored in this paper were the only considerations before us, that it would be possible to take the arguments we have developed and deploy them to argue for targeted export taxes. One could also use them to argue for increases in tariffs which are already lower than 10%. We have not argued this because our own understanding of what the modelling has established is much more limited than this.

Because they operate via the terms of trade effect on exports the arguments here are quite general. So in some senses not proceeding with tariff cuts to the automotive industry is unfair. But the nation is not considering whether to impose export taxes, or whether it should reverse tariff reductions on other industries like whitegoods.

The current policy question is what to do with automotive tariffs. The current argument is not that the authors of the report are such experts that they can divine the precise optimal tariff and that this discloses a level to which all tariffs should be put. Far from it. And it is certainly not an argument that we should impose export taxes at a time when other countries export taxes on agricultural products are driving up global food prices outside the major agricultural exporters and threatening the integrity of the world trading system.

Further it is not an argument that there are no circumstances that would justify a move by Australia to zero tariffs. We should always be prepared to negotiate our trade barriers down, in return for commensurate benefits from negotiating better access to other countries markets as we have sought to do in various multilateral and preferential trading agreements in the past.
Our argument can be summarised by the following propositions.

Any economic gains from lowering tariffs are likely to be small.
Against this there are clear costs.
These costs are also relatively small. However the first effect is likely to be stronger at higher tariffs and the latter will begin to dominate at some point as we get closer to free trade.
Accounting for both effects it is sensible to believe that lowering tariffs from 10% to 5% is much more likely to involve (small) net costs than (small) net benefits.
Because the effects are relatively small, and the precise point at which the optimum is situated is subject to considerable uncertainty, the modelling supports the policy status quo.